U.S. Economic and Interest Rate Outlook - December 2012
December 18, 2012
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- Our year-end forecast looks beyond the fiscal cliff.
Forecasts are always challenging, but the number and magnitude of current uncertainties makes the exercise especially perilous at the moment.
Amid indications that the two sides of the budget debate are iterating towards an agreement, our baseline case assumes that a compromise will be struck before the fiscal cliff hits with full force. Still, it is nearly certain a mild fiscal slope will occur, as some increases in taxes and some reductions in spending will be allowed to take hold.
The final months of this year and the early part of next year will go down as a period of soft economic conditions. We have lowered our estimates of real GDP for the fourth quarter to 1.1% from 1.3%, largely due to the weakness in consumer spending and the impact of political gridlock on confidence. Elements of the fiscal cliff set back the first quarter forecast a tad, compared with the estimate last month. The worst should be in the past as the second quarter of 2013 rolls along.
US Economic Outlook
Key elements of the current forecast include:
- Consumer spending in the fourth quarter will be marked with strength in auto sales and soft non-auto retail sales, based on data available thus far. It is not entirely clear if Hurricane Sandy has played a role in holding back retail sales; additional data should offer more insights. All in, real consumer spending growth should average a little below 1.5% in the final three months of 2012 and first quarter of 2013. The reinstatement of payroll tax cuts should account for a big part of the deceleration in consumer spending in the first three months of next year.
- The housing sector is a bright spot in the overcast short-term landscape. Incoming household sector data on home sales, starts, and prices point to improvements that will make a positive contribution to fourth quarter real GDP growth. Residential investment expenditures should post an annual increase in 2012 (assuming a fourth quarter gain), which will be the first since 2005.
- Business spending is expected to advance at a tepid pace, following the first decline since the recovery began in June 2009. Firms continue to hold back on capital investment amid a modest outlook for growth and a series of potential risks. High vacancy rates and tight credit conditions are curtailing the growth of non-residential construction spending. Inventory accumulation is expected to subtract from GDP growth in the fourth quarter following a sharp increase in the third quarter.A widening of the US trade gap is nearly certain given the soft growth prospects of Americas trading partners in the near term. The recent European Central Bank downgrade of the economic outlook for the Eurozone supports expectations of a tepid contribution from US exports to GDP growth. Chinas exports and imports slowed in November and have diminished the optimism associated with other recent economic indicators.
- The sub-par growth forecast in the near term, combined with moderate momentum from spring of 2013, suggests only a slow improvement in the unemployment rate. Lack of robust demand conditions is consistent with a non-threatening trend of inflation during the forecast period.
- Risks are tilted to the downside, given the political and economic situation in Europe and estimates of growth in Asia pointing to subdued growth. Turmoil in the Middle East is a source of economic risk that could have adverse consequences on not only the US but also the global economy.
- We are assuming that the Federal Reserve will continue its quantitative easing program throughout 2013, providing modest support to growth.
We are tracking negotiations about the fiscal cliff very closely. Stay tuned for the updates about the impact of these talks on the economy.